Book Review: The myth of independence: How Congress governs the federal reserve by Binder,S.,& Spindel,M.

The Federal Reserve (Fed) is widely regarded as an independent central bank and, in the view of many critics, insufficiently accountable to the public for its policies and actions. The Fed wields considerable power over U.S. monetary policy and bank regulation. It lent billions of dollars to financial institutions during the financial crisis of 2007-2008 and purchased trillions of dollars of U.S. Treasury and mortgage-backed securities to promote recovery from the recession that followed. These actions are widely viewed as evidence that the Fed has too much independence.

Or does it? In their book, The Myth of Independence: How Congress Governs the Federal Reserve, Sarah Binder and Mark Spindel argue that the Fed has barely any independence at all. What independence the Fed does have is conditional on its relationship with Congress. The Fed Act of 1913 established the Fed, and Congress has since amended the Act many times. Congress sets the rules under which the Fed operates and exercises considerable oversight of the Fed through hearings, confirmation of appointments to the Fed’s Board of Governors, and various informal contacts. Since 1913, Congress has acted on several occasions to reestablish or modify the boundaries of Fed independence and to require greater transparency in the Fed’s operations.

The Myth of Independence begins by describing the political environment in which the Fed operates, with special emphasis on the Fed’s relationship with Congress. The book’s thesis is that

Congress and the Fed are interdependent institutions—the inevitable consequence of reelection-seeking, blame-avoiding politicians who hold the power to make and remake political institutions . . . Because Fed credibility is vulnerable to congressional-led cycles of blame and reform, Fed success in managing an inherently cyclical economy depends directly on maintaining political support (p. 232).

Much of the book explores the dynamics of legislative attention on the Fed. The authors show that Congress’s focus on the Fed, reflected in measures such as the number of bills introduced to limit the Fed’s discretion or to increase its transparency, rises and falls with the economy’s performance. When times are good, Congress pays less attention to the Fed, but when the economy performs poorly, Congress’s attention increases.

Several chapters review the history of Congress’s actions to shape Fed independence and accountability, beginning with the Fed’s creation in 1913. The authors augment a historical narrative with statistical analysis of congressional voting patterns on legislation affecting the Fed. Politics produced the Fed’s multifaceted structure, consisting of 12 quasi-private Reserve Banks and an oversight board comprised of presidential appointees. This design was intended to ensure that neither the federal government nor the big Wall Street banks could dominate the Fed, and the structure has continued to support the Fed’s political independence ever since. For example, the authors identify several instances when congressmen from cities or states with Reserve Banks voted against legislation that would diminish the Fed System’s independence or reduce the authority of the Reserve Banks within the System.

Although the basic structure of the Fed has never been changed, policy-making authority has become more concentrated in the hands of the Fed’s politically appointed Board of Governors. The original distribution of authority, which gave the individual Reserve Banks considerable policy autonomy, proved unwieldy. Its flaws were revealed when the Fed was unable to mount an effective response to banking panics or the depressed economy during the Great Depression. The Roosevelt Administration then took the lead in redesigning the U.S. financial system and the Fed, with the aim of concentrating the Fed’s authority entirely within its Board of Governors. Congress, with its different interests and constituents, preserved a monetary policy-making role for the Reserve Banks. It severely limited the Fed’s independence, however, by granting new powers to the Treasury Department. These powers effectively gave the Administration the ability to nullify any policy actions taken by the Fed.

During World War II, the Fed’s sole monetary policy objective was to enable the Government to borrow cheaply, which it did by capping the market yields on Treasury debt. The Administration liked this arrangement and the Fed agreed to maintain the caps for several years after the war ended. Eventually, however, accelerating inflation made the caps untenable. In one of the more interesting sections of the book, the authors describe how Congress stepped in to help free the Fed from its commitments to the Treasury. The authors make a strong case that Congress’s support was crucial for the Fed to successfully negotiate an accord with the Treasury in March 1951, which allowed the Fed to chart an independent monetary policy. They write, “Breaking the grip of the Treasury over the Fed promised to bolster the institutional power of both Congress and the Fed (p. 154).”

Of course, neither Congress nor the Administration left the Fed alone in the years following the Accord. Congressional attention increased in the 1970s when inflation rose and the economy performed poorly. Congress placed an explicit mandate on the Fed to pursue monetary policy aimed at achieving price stability and maximum employment—the Fed’s “dual mandate.” Congress also imposed new reporting requirements on the Fed to make policy more transparent. At the same time, however, Congress extended the Fed’s reach over the banking system by subjecting all depository institutions, not just members of the Fed System, to the Fed’s reserve requirements while giving them access to the Fed’s payment services. The authors show that the tendency of Congress to respond to economic crises by both clipping the Fed’s independence and expanding its authority is a recurring theme.

Congress was less focused on the Fed during the “Great Moderation,” roughly the period from 1985 to 2005 when inflation was relative low and stable and fluctuations in economic activity were modest. The financial crisis of 2008-2009 changed all that. Congressional scrutiny of the Fed has since remained high. The Dodd–Frank Act of 2010 curtailed the Fed’s power to provide emergency loans but gave the Fed new authority to regulate systemically important financial firms. Legislation to audit the Fed’s monetary policy making and to require the Fed to set policy by means of an announced mathematical formula gained new momentum as critics charged that the Fed’s large-scale asset purchases usurped the authority of Congress and posed inflationary risks to the economy. At the same time, Congress exerted its authority by refusing to confirm multiple appointments to the Fed’s Board of Governors by President Obama. In this environment of heightened attention, the Fed has had to be especially mindful of its relationship with Congress. The authors describe a particularly interesting example in which Fed Chair Ben Bernanke delayed the adoption of a numerical target for inflation until 6 years into his term while working behind the scenes to garner the support of key members of Congress. This example illustrates that successful Fed chairs “understand that the Fed’s capacity to make politically unpopular—but economically necessary—policy requires building and maintaining congressional and presidential support (p. 237).”

The Myth of Independence is both scholarly and readable. It furthers our understanding of the political environment in which the Fed operates and how and why the limits of Fed independence and accountability have changed over time. The book should be required reading for economists, political scientists, and students interested in the political constraints on the Fed’s power and the interdependent relationship between the Fed and Congress, as well as for those looking to better understand the political forces that have and will continue to shape Fed policy.